Why the United Kingdom must say 'No'
By Rt Hon. David Heathcoat-Amory, MP E-mail: david@wells.tory.org.uk

THE CASE AGAINST

Countries which join a single currency agree to transfer monetary policy permanently to the centre. In the case of Europe, interest rates will no longer be determined nationally but by the Governing Council of the European Central Bank (ECB), at which each national representative has undertaken not to be influenced by the home government.

Interest rate and other monetary decisions would, of course, be taken for the currency area as a whole. There could be no separate interest rates for sub-groups or individual countries. National exchange rates would also cease to exist. What, therefore, would happen if economic conditions diverge and one country, or group of countries, found itself in different economic circumstances? Is this likely to happen and what would be the consequences?

It was seen during the brief description of economic events since 1970 that plans were often defeated by unexpected disturbances or shocks which affected countries or regions in different ways. A shock which affects all members of a single currency area in the same way (called 'symmetric') may be dealt with by a common policy instrument such as a change in the single interest rate. Others shocks ('asymmetric') affect them differently. For instance an increase in commodity prices, such as oil, would affect producer countries differently to those reliant on imports. Or a shift in world demand for manufactured goods, or agricultural products, or financial services, would affect those countries specialising in them.

A country within a single currency zone, experiencing a negative shock - one that lowers output and employment - cannot, of course, devalue. Nor can it lower its interest rate: control over that has been transferred to the ECB which can only respond to the needs of the currency area as a whole.

The necessary adjustment must therefore either take the form of a migration of labour away from the relatively depressed country to others experiencing higher relative activity or local wages and prices must decline in real terms.

There have been many studies of the mobility of labour within Europe compared with other single currency areas such as the United States. (Note 6) They show that labour mobility is significantly lower within individual European countries than in the United States or indeed, Japan. Mobility between European countries is lower still, reflecting the barriers to movement created by, among other things, language, culture and differences in social security systems.

Nor does the EU officially encourage the idea of labour migration. Instead the reassuring notion of 'community' holds out the prospect of work being provided on site. The Commission described regional mobility of labour as 'neither feasible, at least not across language barriers, nor perhaps desirable.' (Note 7)

That leaves reductions in real wages and prices. This could be a most painful process. If inflation was low, it might have to include actual, nominal wage reductions. That this is unlikely to happen is shown by the experience of Britain's return to the gold standard in 1925, attracted by the prospect of sound money. The rigidities of the labour market meant that although retail prices fell from 1925 to 1929, earnings rose and the strain of an overvalued exchange rate was taken by the traded sector of the economy with consequential loss of market share and a steep rise in unemployment. In 1931 Britain left the gold standard, permitting an exchange rate adjustment.

In the EU today the development of the Social Chapter, and indeed the whole thrust of Community social and employment legislation, creates the same rigidities and even less prospect of the wage-price mechanism adjusting readily to external disturbances. A minimum wage has the same effect. The European Socialist Group has called for even more restrictive employment laws as a condition of its support for a single currency.

Thus the necessary conditions for a single currency - mobility, flexibility and a smoothly functioning wages market - are actually being eroded. This is being done by the very institutions - the Commission, the European Parliament and left-of-centre parties - which are most in favour of a single currency. Seldom can there have been a more contradictory muddle of policies and aims.

It is sometimes argued that increasing economic integration will iron out the differences between EU countries and make it less likely that shocks will affect countries in different ways. This is not borne out by experience. Trade is not necessarily a levelling influence. On the contrary what drives trade is comparative advantage, in other words differences, and the workings of the market lead to specialisation. This could actually increase differences between Member States.

For example, in the United States the production of automobiles is much more regionally concentrated than in the EU. There is no doubt that the US market is more highly integrated than the EU market. This evidence suggests that when the European Single Market moves forward to completion, automobile production will become more concentrated in fewer Member States.(Note 8)

Even without new differences, the existing economies of the EU show great variety and diversity. Some countries have large agricultural sectors, Germany has a particularly important manufacturing sector, and the UK has a larger financial sector than the others as well as being the EU's only oil exporter. External shocks will therefore often affect different countries in different ways. It is important to bear in mind that these shocks do not have to be sudden or dramatic like an energy crisis. It is part of the dynamism of the world economy that there are constant changes in the supply and demand patterns, productivity growth and the behaviour of real wages. Thus, the Japanese yen appreciated in real terms in the 1960s and 1970s to offset rapid productivity growth in Japan's export sector.

In a single currency area, without the possibility of internal exchange rate adjustments, it is the local wage and price level that must take the strain of readjustment. As noted above, such prices are notoriously 'sticky' downwards and the notion that wage bargainers would automatically adapt their demands to the requirements of a remote central bank is, at best, highly optimistic.

Differences between the UK and continental Europe are particularly significant. Not only is this country a large oil producer but its pattern of trade is distinctive, being much more dependant on invisible earnings (services and investment income) than other EU countries. Trade in these invisibles has grown half as fast again as visible imports and exports since 1970, and the UK has a much higher degree of inward and outward direct investment (relative to GDP) than any other major country. The surplus on such investments, and earnings from services, helps to offset the visible trade deficit but it is striking that the invisible surplus is earned outside the EU. The UK has a trade deficit with the EU in all categories. This illustrates the importance of global trade to this country, and also underlines that we are particularly affected by world economic trends.

Disturbances, or divergent trends, could also be made worse by the way different economies respond differently to the same influence. For instance an interest rate change by the ECB would have a differential effect on Member States. The UK has a high level of variable mortgage debt. Other countries rely more on fixed interest loans. Therefore, an interest rate change would have a more direct and immediate effect on the UK economy.

A further difference is that the UK business cycle is not closely synchronised with other Member States. We entered the recessions of the 1980s and early 1990s sooner and emerged from them earlier, so common policy prescriptions might have had an exaggerating rather than a counter-cyclical effect.

The plain fact is that Europe is very diverse. There is no 'European economy'. Constituent countries show great variety in their financial and capital structures, labour markets, productivity rates, industrial specialisations and social security systems. Forcing them into the same mould of a single currency is hardly rational.

In summary, disturbance or shocks are a feature of the world economy. They are by definition unpredictable but have occurred often in the past and since 1970 have derailed most of the plans for monetary union in Europe. In addition there are slower acting but constant shifts in productivity, costs and demand for goods and services.

Many of these changes impact on countries differently, and the diversity of European economies makes this unsurprising. The structure and trade patterns of the UK economy are particularly distinct.

In a single currency area the option of exchange rate adjustment is permanently removed. Monetary control is transferred to a single Central Bank which determines a single interest rate. This then applies indiscriminately to all participating countries.

The adjustment mechanism for these changes therefore falls either on labour mobility, which is low in Europe, or on price and wage adjustments which would have to be downwards in a country negatively affected. There is plenty of evidence that such adjustments do not take place, and certainly not quickly or easily. Moreover, the whole thrust of EU social development has been to inhibit labour market flexibility. Faced with this impasse and deprived of normal economic levers, national politicians would come under great pressure to find other ways to respond, particularly in an enduring recession.